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Internal Communications and the FINRA Advertising Rules: What does FINRA's Proposed Guidance Mean for Member Firms?, Contributed by David A. Thompson, Bingham McCutchen LLP

Wednesday, December 7, 2011

Member firms of the Financial Industry Regulatory Authority (FINRA) often communicate internally about products or services offered through the firm, and label documents that are not to be shared with persons outside the firm as “internal-use only” material. Communications that are purely internal, and not shared with anyone outside the firm, are often supervised as part of the firm’s training or general supervisory procedures. In recent years, however, FINRA has contended, primarily in the context of enforcement actions, that internal communications not shared with persons outside a member firm can be “Institutional Sales Material” under National Association of Securities Dealers (NASD) Rule 2211, and therefore subject to the standards FINRA uses to evaluate communications with members of the public under NASD Rule 2210(d)(1). NASD Rules 2210 and 2211 are commonly referred to as the “advertising rules,” and address the approval, recordkeeping, filing, review requirements, and content standards for six categories of “Communications with the Public.”1 Rule 2210(d)(1), titled “Standards Applicable to All Communication with the Public,” requires (among other things) that communications be fair and balanced, and that they provide a sound basis for evaluating the facts in regard to any security or type of security (hereafter referred to as the “Content Standards”). The Content Standards prohibit members from omitting any material fact or qualification that would cause the communication to be misleading, and prohibit members from making any false, exaggerated, unwarranted, or misleading statement or claim in any communication with the public. FINRA’s recent position regarding the interplay between the Content Standard rules and purely internal materials has not yet been adjudicated by a FINRA hearing panel or the Securities and Exchange Commission (SEC). Indeed, many in the financial industry are not aware that "internal-use only" material may be scrutinized for compliance with the advertising rules during regulatory examinations or by the FINRA Department of Enforcement.

FINRA's Proposal

To erase any ambiguity on this point and as FINRA contemplates revisions to the Consolidated Rulebook,2 FINRA now has proposed formalizing its interpretation of NASD Rule 2211 as it relates to internal communications. FINRA does not recommend changes to the relevant parts of the current rule as one might expect. Instead, it proposes to add an interpretive statement to the rule entitled “Supplementary Material 2210.01.” As drafted, the statement instructs that “a member’s internal written (including electronic) communications that are intended to educate or train registered persons about the products or services offered by a member” will be considered “Institutional Communications.” On November 1, 2011, the SEC issued a release calling for additional public comment on the proposed FINRA advertising rules, including Supplementary Material 2210.01, and instituting proceedings under Section 19(b)(2)(B) of the Securities Exchange Act of 1934 (Exchange Act) to determine whether to approve or disapprove of the proposed rule change.3 FINRA’s policy concern behind the proposed supplemental statement is clear and to be commended. Training materials used to educate registered persons about the increasingly complex products in today’s financial marketplace should be fair and balanced. Such materials often form the basis for what registered representatives will later say to prospective customers, and they arguably form the basis for future advertising. Traditionally, however, member firms have viewed internal training materials as part of their training or supervisory programs; they have not considered them subject to FINRA advertising rules. Member firms have also not traditionally reviewed purely internal communications for compliance with the NASD advertising rules.

Open Issues

From a member firm’s perspective, the training of registered representatives is a matter fundamentally different than communicating with external parties, even institutional ones. A firm’s training of registered persons, unlike communications with a third party, are made in the context of a supervisory relationship. The firm knows, or should know, the training needs of registered persons, and can tailor each communication with them as part of an overall training program. The firm bears the responsibility under current supervisory and training rules to provide accurate training, and FINRA has various mechanisms under current rules to bring regulatory actions against firms that provide inaccurate information to their employees.4 Against this backdrop, there is reason to question whether FINRA's advertising rules are the best regulatory framework within which to address the accuracy of internal communications about products and services. FINRA's proposal also raises significant questions about how member firms will comply. For instance, the interpretation includes electronic communications that are intended to educate or train registered persons. How will firms establish procedures for the review by an appropriately qualified registered principal of internal e-mail communications intended to educate or train registered persons?5 If such materials are “institutional communications,” they must be captured and reviewed, at least on a periodic basis, as part of the firm’s supervisory procedures. Moreover, Supplementary Material 2210.01, on its face, does not address the training of unregistered employees of a member firm. Are those communications also subject to the advertising rules, and if so, how are the content standards different from the standards that would apply to communications with the investing public and with registered employees? How will member firms distinguish e-mail messages to registered persons from e-mail messages to unregistered persons? These issues have, to some degree, flown under the radar during the comment process, in part because FINRA did not include Supplementary Material 2210.01 in its initial rule proposal in 2009.6 It was added only in the revised proposal filed in July 2011, which had a shortened comment period.7 Four industry comment letters opposed adding Supplementary Material 2210.01.8 On October 31, 2011, FINRA filed a response to the comments received,9 and, an amended version of the proposed advertising rule (the Proposed FINRA Advertising Rule).10 In its October 31 response to comments, FINRA stood by its proposal to add Supplementary Material 2210.10, stating that its position on internal material was “consistent with current FINRA rules and FINRA’s current and past interpretations of those rules.”11 The SEC, however, called for public comment, so the issue is once again on the table and the industry has another opportunity to be heard. Whether approved by the SEC or not, there is no doubt that FINRA’s filing has significant implications for member firms. FINRA’s proposed guidance articulates, for the first time, the circumstances under which "internal-use only" material will be subject to FINRA's advertising rules. Supplementary Material 2210.01 states: Internal Communications. A member’s internal written (including electronic) communications that are intended to educate or train registered persons about the products or services offered by a member are considered institutional communications pursuant to paragraph (a)(3) of this Rule. Accordingly, such internal communications are subject to both the provisions of this Rule and NASD Rule 3010(d) (Review of Correspondence). If approved by the SEC, the statement will have the practical effect of becoming part of the rule, even though the definition of “Institutional Communication” and “Institutional Investor” will remain unchanged. The interpretation will be an integral part of the new regime. If not approved, the status of FINRA’s interpretation may depend on what position the SEC takes as part of its ongoing proceedings. At stake is not just a rule change, but a statement of FINRA’s current view. In the meantime, the filing puts firms in the rather awkward position of determining whether the proposal itself

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